Are we already in a recession?
Inflation, recession and central bank actions. The analysis by Jeffrey Cleveland, Chief Economist of Payden & Rygel
Fed officials have talked unofficially to some news outlets in the past. The push for greater transparency by the American central bank should have limited the use of these methods, but the complexity of the current situation has prompted the Fed to communicate to public opinion directly its awareness of the fact that inflation is a problem that needs to be addressed.
The whole press conference, however, seemed rather confusing and the Fed gave the impression that it did not have a coherent view on the causes of inflation and the possible resolution of the problem. On the one hand, Powell explained that many of the factors driving inflation are due to "shocks" (such as, for example, the Russian-Ukrainian crisis) but, on the other, he reiterated the need to rebalance demand with respect to the 'offer. Without having real knowledge of the disease, finding a suitable cure is complicated and the likelihood of error increases.
Moreover, to date, forward guidance seems to no longer have any value and, indeed, the fact that the Fed is focused on monthly changes in the CPI, in food and energy prices, in inflation expectations and in consumer sentiment, indicates that the reactions and responses of the central bank will be defined on a meeting-by-meeting basis.
If we look at the rate hike, in the light of the dot plot it is clear that the Fed is still lagging behind the curve. In theory, to contain inflation, it would have to adopt a tight monetary policy, but with the current trajectory, the monetary policy rate could rise above the neutral rate by September, after which the impact would only be felt with some delay. However, financial conditions have already tightened significantly, which will have a major impact on markets and the economy.
The new economic estimates are too rosy
After the last FOMC meeting, it is questionable whether the projections were more correct than forecasts. Financial conditions have tightened a lot, the Fed will continue to raise rates, but will the unemployment rate rise only modestly as inflation falls? We hope this will happen, but we don't believe that investors should consider this scenario as the central case.
What is the Fed willing to sacrifice to declare inflation "mission accomplished"?
Based on their projections, policymakers expect slower growth and a modest rise in unemployment to achieve price stability. So in their view some "economic pain" is a prerequisite for bringing down inflation. Economist Bob Solow once said that central banks trying to weed out inflation from the system "burn the house to roast the pig."
Does the Fed have to hope for luck to have a soft landing?
All of this leads us to believe that Powell's chances of a soft landing are slim. Given the rapid tightening of financial conditions, we are already seeing a slowdown in the real estate sector and layoffs have started to rise, albeit from low levels. But historically it is enough for layoffs to rise slightly from their lows to mark the beginning of a slowdown. Inflation-adjusted consumer incomes are suffering from rising prices, which will hold back spending growth in the second half of the year.
Are we already in a recession?
The answer depends on what is meant by a recession. GDP growth in the first quarter was negative and in the second it also appears to be sluggish. It is therefore possible that there will be two consecutive quarters of negative growth, even if the recession is defined differently by the National Bureau of Economic Research, which looks at industrial production, consumer spending, employment and sales and tests whether each of these indicators has moved away from its peak.
The Fed is not the only aggressive central bank, but we believe it is particularly at risk of an excessive correction, meaning that its monetary policy has been expansive for too long and now risks being too tight. Similar moves have been made by the Bank of England, the Swiss National Bank, the Bank of China and perhaps even the ECB. The Bank of Japan appears to remain the only one out of trend, but each central bank's paths will be different.
After an emergency meeting, the ECB said it was working on a new tool to counter rising financing costs. Are you buying time or are you late in figuring out what to do?
As for the ECB, it seems a serious oversight that the measures announced in the last extraordinary meeting were not activated before the monetary tightening. Or it was a mistake to think that using current programs would have been enough to contain peripheral spreads. However, in defense of the ECB, it must be recognized that Europe faces greater institutional challenges than the Fed.
In general, are the markets telling central banks what to do?
Central banks seem to be chasing the markets today, even if they can't admit it. The bond market started pricing hikes last fall and the Fed followed suit. Then the bond market priced even higher in early 2022 and central bank rhetoric changed again. Following the release of the US CPI report in early June, the bond market began pricing a 75 basis point chance, then the Wall Street Journal article gave the green light. There is a feedback loop: Central bankers focus on certain inflation expectations, but if market inflation expectations become “ungrounded,” central banks panic. In our view, central bankers want to make highs already priced by the markets to maintain their credibility, but this could be a dangerous and difficult game to play.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/siamo-gia-in-recessione/ on Sun, 26 Jun 2022 14:04:05 +0000.